By Hrishikesh Menon. Edited by Swastik Patel
With inflation at 40-year highs and oil prices at the center of attention, it is important to know about the macroeconomic impact of oil price changes. A common misconception is that lower oil prices are best for all nations and its consumers, but that could not be further from the truth. It is true that there is a net positive to lower oil prices, but changes in both directions are essential.
Parts of the GDP
Before we dive into the specifics of oil prices and the GDP, let’s acquaint ourselves with the other sectors which contribute to the GDP. The World Bank’s website categorizes the world GDP into four different economic sectors: agriculture, industry, manufacturing, and services. Oil & gas falls under the industry sector which has a share of 26.3% of the World GDP as of 2020. This shows even though there are many sectors and industries contributing to the GDP, oil has a substantial effect on it.
Oil price increase
During COVID, as all economic activity came to a grinding halt, oil prices tanked to negative values. However, due to the post-pandemic boom in growth and demand, oil prices skyrocketed to higher than pre-pandemic levels. This increase in prices has two effects: one on the average consumer and one on the nation. High oil prices mean high gas prices, which contributes to the decrease in disposable income, which in turn hurts economic activity and the GDP. The effect on the country would depend on whether they are a net importer or exporter of oil. Net exporters usually benefit from oil price increases as they would make a bigger profit and increase the importers’ dependence on their oil. Examples of such nations are Russia, Saudi Arabia, and the United States. Net importers are the opposite, and higher oil prices would hurt them as oil is more expensive to buy. To sum up, oil prices increasing causes a lot more damage to the GDP than good.
Oil price decrease
This is the much more desirable situation for the GDP as they have benefits for both the consumer and the nation. Low oil prices mean low gas prices therefore more money in the hand of consumers which increases economic activity. Low oil prices also mean it’s cheaper for net import countries to increase their supply. The only downside is for net exporters who would miss out on some profits, but in the long run, the benefits trump the downside.
With alternative energy sources on the rise, soon oil will not have the grip on the GDP it has today. Regardless, until then oil price increases will continue to hurt the GDP (consumers have less money and countries can’t import as much) and decreases will benefit it (consumers have more money and countries can import more).